A consideration of the main factors at play behind the current San Francisco real estate market, some of which reflect general macro-economic trends and some of which are specific to the city itself. As we've seen in 1989, 2001 and 2008, many of these factors can stall or go into reverse very quickly in the event of a large, negative, economic, political or even ecological event.

In 2016, the market in San Francisco started to cool off somewhat after 4 years of a ferociously high-demand/ low-supply dynamic. By any national standard, it is still a strong market, especially in the more affordable price segments, but it has distinctly changed with listing inventory increasing and buyer demand softening. We discuss many of the moving parts behind current market conditions in our June and July newsletters: Wealth,
Employment, Demand, Inventory, Affordability and San Francisco Home Prices and A Soft
Landing?. The factors listed below are still in play, but there appears to be the beginning of a transition.

Population growth: San Francisco has recently been adding approximately 10,000+ new residents per year and new home construction has not come close to adding enough additional housing units to meet increased demand. New construction is booming again in the city, and tens of thousands of new housing units are now somewhere in the planning and construction pipeline, but so far not enough new units have arrived on market (to rent or to buy) to substantially change the existing high-demand/low-supply market dynamic. It will be interesting to see how this plays out in the next few years as more inventory arrives.

Employment growth: San Francisco has recently hit new highs in the number of employed residents and its unemployment rate is as low as it has ever been. Many of these new jobs - in high tech, bio tech and professional occupations - are very well paid.

Approximately 12,000 - 14,000 units of housing have been built in San Francisco since 2010. Over the same 6 years, the number of employed residents has increased by about 100,000. In light of the mismatch between supply and demand, the pressure on housing prices is not surprising. Employment actually dropped in the first 6 months of 2016 and then surged again in July to its highest point ever.

Stock market upswing: Though there has been some major volatility this past autumn and in early 2016, the S&P 500 is still up approximately 60% from 2011. The affluent have benefited most from the recent, large increase in the value of financial assets, and San Francisco has one of the most affluent populations in the country. When people feel wealthier, they spend more on homes, second homes and real estate investment properties. However, beginning in summer of 2015, various economic "crises" (China's stock markets plunge, oil price plunge, Brexit) have affected national and international stock markets, inserting periods of high volatility. The net result is that as of late July 2016, the S&P 500, though hitting a new record, is only a tad above its previous high in May 2015.

Brand new wealth: Thousands of newly affluent residents – including significant numbers of millionaires and even billionaires – have been created in the Bay Area in recent years from stock options, IPOs and company sales. This is super-charging the “wealth effect” on the market. According to Wealth-X, San Francisco ranks 3rd in the nation for number of "ultra-high-net-worth" residents.

It's also interesting to note that: "San Francisco ranks first among U.S. cities in income mobility — the opportunity to rise upward on the income scale — thanks to its schools, its growing economy and its compact physical size that doesn’t produce walled-off divisions." (San Francisco: a city pushed to new limits and opportunities)

High rents: Purchasing a home in San Francisco, with the attendant multiple tax benefits, being able to take advantage of low interest rates, and equity accrual (as well as the possibility of future appreciation), often makes compelling financial sense if the alternative is to pay an extraordinarily high rent (with none of those benefits). SF rents started to plateau in mid-2015 and have probably dropped a little so far in 2016, though they are still the highest in the country. Our full report is here: Bay Area Rent
Report

Low interest rates: from 1996 to 2006, the average interest rate on a 30-year fixed rate loan was approximately 6.3%. As of late July 2016, it was running under 3.5%. That 44% reduction in the cost of financing makes an enormous difference in affordability and the ongoing cost of housing. Since the Fed raised the benchmark rates for the first time in many years in mid-December 2015, rates have actually dropped due to one international crisis or another (the latest being Brexit) . It is extremely difficult to predict interest rate movements, but if rates do rise appreciably, it will certainly affect housing affordability.

Renting instead of selling: Very high rents and very low interest rates have
convinced some owners who would have sold
their homes to rent them out instead, and the Airbnb rent-to-tourists option is probably adding to this (even if in many instances, it violates city statutes.) As an adjunct to the financial calculation for renting instead of selling, we are also hearing from some owners that they are afraid that if they sell now, they or their children will never be able to afford to move back. All this further
depresses the supply of new listings coming on market, exacerbating the
inventory shortage.

Not selling as frequently: According to a November 2016 report by ATTOM Data Solutions, "homeowners who sold in the third quarter [of 2016] had owned their home an average of 7.94 years — a new high in our data and substantially higher than the average homeownership tenure of 4.26 years pre-recession." If this is indeed true and not simply an anomalous short-term fluctuation, it goes a long way to explaining low inventory levels of homes on the market available to purchase.

Work there, live here: A relatively recent development, many of the people working or taking new jobs in Silicon Valley high-tech and bio-tech now insist on living in the city, creating what might be called a "reverse commute" from past patterns. The “Google bus” phenomenon is just one illustration of a trend which puts considerable additional pressure on our housing market.

Magnet effect: San Francisco, a small city of 7 by 7 miles, is now the capital of perhaps the fastest growing, most lucrative, highest-prestige business segment. It is also in one of the most beautiful, best educated, most tolerant and culturally rich metropolitan areas in the world. That makes the city a magnet for smart, creative, ambitious people from all over the planet and they are willing to pay a premium to live here.

There has clearly been a general demographic trend for post-college adults, aged 24 - 39, to move back into urban core areas - and that certainly is dramatically occurring in San Francisco. (See the books, "The Great Inversion & the Future of the American City" and "Who's Your City? How the Creative Economy Is Making Where to Live the Most Important Decision of Your Life.")
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Limited supply: Almost two thirds of the city’s housing is in rental units, much of it under rent control. The number of homes suitable for owner-occupancy and available to purchase each year is relatively small, usually 6000 to 8000 units. The SF homes market is less than half the size of the markets in either Alameda or Contra Costa counties.

Furthermore, new housing construction simply has not been adequate to the city's needs over the past 35 years. 49% of San Francisco’s housing stock was
built prior to 1940. As seen in the chart below, the surge in
population during WW II led to a burst of building, which then steadily
declined to clearly insufficient levels until the big increase in condo
construction at the end of the 1990’s. The 2008 market crash ended that cycle,
and the current feverish boom in home construction has been quickly gathering steam only
in the past few years - however, as increasing volumes of new-construction housing units come on market, it may significantly alter the supply and demand dynamic that has prevailed 2012 - 2015. Worth noting is that ever since the mid-1990's the units being built are typically 1 or 2-bedroom condos or apartments, instead of 2 and 3-bedroom houses, i.e. the new housing units being added accommodate fewer people per unit. Our updated report on new housing construction in San Francisco is here: SF Housing
Inventory & Construction Report

Tax benefits: We won't count this as one of the 10 factors behind the current market, because the enormous tax benefits of homeownership in the U.S. are always present, boom or bust (until Congress legislates large, unexpected changes to U.S. tax law), but still they are a big factor underlying the housing market. Being able to deduct interest costs and property taxes allows homes to cost (much) more and yet remain affordable to buyers. And there is also the $250,000/ $500,000 exclusion of gains realized upon sale of a primary residence from capital gains taxes: There is not another financial investment we can think of that allows one to reap profits of this magnitude without any tax liability. It's interesting to note that the tax benefits of homeownership in this country are rarely found anyplace else in the world.

This chart below is a simplified, smoothed-out and approximate look at the last few real estate cycles in the San Francisco Bay Area, illustrating estimated percentage changes in home prices from successive peaks and bottoms of the market. The years between these high/low points are simply depicted here as straight lines (which does not reflect reality). Different market segments - areas, property types, price segments - have experienced varying appreciation and depreciation rates over the years and how this chart applies to any specific property is unknown without a tailored analysis.

We want to reiterate that none of this implies justification for an ever-appreciating real estate market: Almost all these factors can stall or even go into reverse, and as mentioned earlier in 2016, conditions have cooled. Real estate and financial markets are prone to a wide variety of extremely complex and hard-to-predict economic and political factors – and they typically go in cycles: up, down, flat, up again (repeat). And economic and market fluctuations are not uncommon within cycle phases. Still, these are, we believe, the fundamental realities underpinning the city’s homes market now.

San Francisco’s real estate market is now heading into the beginning of its 5th year of its current market recovery since the crash and recession that ran 2008 - 2011. In the last few cycles, recoveries have typically lasted 5 to 7 years before a significant market adjustment. Much depends on how strong and sustained the current high-tech boom turns out to be.

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